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Private equity investors are all over secondary deals – handing billions to funds that step in when other private equity investors want to bail on their commitments to buyout funds.
For a time, a big draw was being able to purchase stakes in portfolios at cut-price rates from buyers in a rush to get out. As the money has come in, the discounts have disappeared, but those in the business say there are still reasons to buy second-hand in the private equity world.
The amount of fundraising of late is staggering. In a business that generates about $25-billion a year (U.S.) of transactions (though this year's pace is even hotter), recent fundraising just announced or under way has approached that total in a matter of months. There is the $9-billion just raised for secondaries by Ardian, a fund manager that is probably better known by its old name of AXA Private Equity. Bloomberg reports that Deutsche Bank's private equity arm is looking for $1-billion, Blackstone Group is seeking $3.5-billion and Lexington Partners is looking for $8-billion. Canada's Northleaf Capital Partners just closed on a dedicated specialty fund that brought in $255-million (Canadian), about 25 per cent more than Northleaf went out looking for.
And on top of all that buying power, pension funds are active in the space, too. Just last month, Canada Pension Plan Investment Board put up $477-million (U.S.) to buy out other investors in a JW Childs buyout fund that has been running since 2002.
The discounts in such secondary deals are shrinking fast, and disappearing outright in some cases. Figures from secondary advisor Triago, quoted in the Wall Street Journal, show that the average discount to net asset value on a secondary sale had declined to about 7 per cent in 2013 from 35 per cent in 2009 when the financial crisis was in full swing. Carlyle Group co-founder David Rubenstein recently characterized the discounts as "extremely modest," while another market participant noted the advent of "par pricing." Some in the industry report bids going over par.
So, if you're not getting a cut-rate price, what's the appeal? Jeff Pentland, a managing director at Northleaf, says there are still advantages, and that some investors Northleaf deals with have urged the firm to raise a specialized secondary fund.
A buyout fund that has aged may be through the fallow period early on when returns are slim to none, and into the later, higher-return years when portfolios are generating cash from exits and refinancing, and are able to pay distributions. (In industry argot, this is known as being "through the J curve".) Also, while an investor in a new buyout fund has to deal with concentration risk in the early years of a fund, when the fund may only have one or two companies in its portfolio, buying a stake in an existing fund with numerous holdings can reduce that danger.
"There are some who see secondaries as a way to kick-start returns," said Mr. Pentland. "It mitigates the J-curve, creates diversification from the get-go and accelerates the investment program."
In other words, it's not all about the discounts. Though Mr. Pentland said his firm is still hoping to find better prices by avoiding the really hotly contested sales at the higher end of the market, where fund stakes are often auctioned off.
From the supply side, there continue to be more willing sellers. Some are financial services firms that are getting out of alternative investments due to regulatory changes. Others are portfolio managers using the more liquid secondary market to prune their holdings. According to a recent survey by Coller Capital, 42 per cent of private equity fund investors surveyed planned to sell assets in the secondaries market in the coming 24 months.
"Investors continue to see the secondaries market as an important tool for changing the overall composition of their portfolios," Coller said. In North America, almost all those who plan to sell want to focus on their best performing managers . They also use secondaries as a way to rebalance holdings.
Northleaf, which runs about $5-billion of assets, isn't a rookie in the market. The firm has been taking part in the secondary market in its regular PE funds. Investors wanted more, prompting the firm to raise Northleaf Secondary Partners.
"Investors were seeking a dedicated fund," Mr. Pentland said.